Cap Rates Remain Steady

While hotel capitalization rates hold steady in the current healthy market environment, the increasing need for capital improvements as assets age can affect values and rates of return. This article evaluates the impact of cap ex on hotel capitalization rates and investment exit strategies

Investors, lenders, analysts and appraisers look to the market to provide guidance on capitalization rates that are employed in their underwriting and valuation of income producing properties. Capitalization rates, which express the relationship between a property’s net income and its value, are commonly derived from actual sales transactions. A capitalization rate may be reported by a broker or other party to the sale or derived if the net income of the property at the time of the sale is available. While market participants often talk about what the cap rate is based on (historical or forward looking cash flow), the cost of capital improvements is rarely discussed and is often a hidden cost in transactions.

HVS derives capitalization rate and yield data from hotels that we appraise at the time of sale. Cap rates have been relatively stable over the past three years, reflecting a healthy market in terms of hotel operating performance and transaction activity. The following chart sets forth derived capitalization rates for three general product categories − Full Service/Luxury; Upscale Select Service and Extended-Stay; and Limited Service − derived by dividing a property’s historical TTM net income by the actual sales price.